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Monday December 14, 2009 - 12:40:19 GMT
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Economics Weekly - UK PBR: fiscal austerity delayed until recovery becomes entrenched; Weekly economic data preview - Fed to reiterate low interest rates warranted for an ‘extended period’

Economics Weekly - 14 December 2009

 

UK PBR: fiscal austerity delayed until recovery becomes entrenched

 

Overview

In terms of the stance of fiscal policy there is little new in the chancellor’s 2009 Pre-Budget Report compared with Budget 2009. It confirmed that government borrowing would continue to bridge the gap between government revenues and government receipts opened up by the financial crisis and the recession. This means that the budget deficit will be close to 13% of gdp in the next financial year. In the last financial year, borrowing has been revised up by £5.4bn to £95.4bn. In the current financial year, the budget deficit has been revised up by £2.6bn to £177.6bn.

This is a little less than expected but nevertheless confirms a picture of continued government borrowing in order to ensure that economic recovery takes hold. Predictions for 2010-11 have also been revised up modestly to £176bn from £173bn in budget 2009. Projections further out are little changed, with the budget deficit in 2013-14 expected to be £96bn – a rough halving compared with borrowing for this year and next. Both this year’s and next year’s gdp projections are in line with the consensus. Beyond that, however, the economic growth projections are higher than the consensus.

 

Fiscal arithmetic

The UK government has a delicate balancing act between ensuring economic recovery takes hold, and therefore not tightening policy too soon, and yet giving sufficient confidence to financial markets that it is tackling the widening debt position in future years. Even if the halving of the fiscal deficit is achieved in 2013/14, it will still leave the UK with outstanding debt to gdp of nearly double the level prior to the onset of recession in 2008. The actual debt to gdp ratio of around 80-90% will be in line with international norms for advanced economies. However, stabilising at that level, implies that the yearly borrowing that the PSBR shows will have to cease.

 

Economic outlook

The chancellor’s medium-term gdp projections were unchanged from those published in the April Budget. After dropping by a revised 4.75% this year, the Treasury expects gdp to grow by 1-1.5% in 2010, and by 3.25-3.75% in both 2011 and 2012. While the forecasts for this year and next are in-line with the consensus of independent forecasters, they remain more upbeat further out. Moreover, the recovery relies heavily on a rebalancing away from consumer spending towards investment and net exports. With little in the way of additional fiscal restraint announced, the anticipated improvement in the public finances requires a sustained economic recovery. If this fails to occur, the government may be left having to tighten policy more aggressively to meet its stated target of halving the deficit by 2013/14.

 

Company impact

Further measures were announced in the PBR to support small and medium-sized companies, including the deferment of the planned increase in small companies’ corporation tax rate, and infrastructure and innovative industries. Employer national insurance contributions, however, will rise by a further 0.5% from 2011-12.

 

Financial market reaction

What has been the market reaction to the 2009 Pre- Budget Report (PBR)? Looking at the equity market,

the reply has to be that, on balance, it has been negative. After the PBR, the FTSE 100 closed lower on the day, but was higher at Friday’s close. In which industry sectors did the largest declines occur? Using the FTSE All Share index breakdown by industry, it appears to have been largely in construction materials and in real estate investment trusts. Oil and gas and pharmaceuticals and biotechnology were also negatively impacted, though more modestly. This market reaction, however, should not be exaggerated: overall, the change has been small. December’s PBR did little to alter the underlyingarithmetic of the debt / borrowing nexus compared with what was in the 2009 Budget itself, and in financial market expectations of what was likely to be in the PBR.

 

The three month Libor rate was unchanged on Thursday after the PBR, after falling modestly on Wednesday. Commentary around the need for further fiscal tightening persisted, even after a PBR that starkly showed the intention for a sharp reduction in the level of borrowing, highlighting the likelihood that official short term interest rates will stay low for some considerable time. True, the level of debt does not fall, but the amount borrowed is planned to fall dramatically. In this scenario, it is clear that there will be pressure on monetary policy to offset some of the fiscal tightening that is planned.

 

Sterling was already trending lower before the PBR but continued its slide afterwards. Worries about the UK’s credit rating as the deficit climbs, and especially in view of Greece’s recent rating downgrade, seems to be putting selling pressure on the currency. But the move has not been large, under 1%.

 

Bond yields rose on the PBR, as gilt prices fell back. However, gross bond issuance was not materially higher than already announced in Budget 2009. Bond prices were falling ahead of the PBR and continued to do so afterwards. Of course, there was also turbulence in financial markets about the risks for sovereigns from rising debt and higher government borrowing. The PBR did not halt the rise but neither did it precipitate it. All in all, the PBR seems to have been received as a work in progress in financial markets, with rising speculation about what will be unveiled in the next actual Budget, due in spring 2010.

Trevor Williams, Chief Economist, Corporate

 

Editorial comments to:

Trevor Williams

Chief Economist

Lloyds TSB Corporate Markets

Economic Research

10 Gresham Street

London, EC2V 7AE

Tel: +44 (0)20 7158 1748

 

Weekly economic data preview - 14 December 2009

 

Fed to reiterate low interest rates warranted for an ‘extended period’

 

􀂄 The Federal Reserve’s open market committee (FOMC) is expected to follow the recent decisions by the ECB, BoJ and BoE and keep interest rates pegged at a record low of 0-0.25% on Wednesday. However, in the accompanying press statement, financial markets will also be looking for confirmation that the FOMC still believe that this is likely to remain the case for an ‘extended period’. After the comments from Fed chairman Bernanke last week, playing down market expectations of an early rise in US interest rates, they are unlikely to be disappointed. We forecast the first hike sometime in the second half of 2010. The Fed’s main focus for now is likely to remain on how to continue with its various ‘non conventional’ schemes in place to support credit markets and economic activity. We believe there is a small risk of an extension to the previous timetable of asset purchases next year. The BoJ is expected to keep its overnight interest rate at 0.1% on Friday, with the recent intensification of deflation suggesting this may remain the case throughout 2010. In other events, the Senate Banking Committee holds a confirmation vote for the nomination of Fed chairman Bernanke to a second term on Thursday. The BoE will publish its Quarterly Bulletin on Monday and its December Financial Stability and Trends in Lending reports on Friday.

 

􀂄 It is a busy week for economic data this week, with financial markets searching for clues about both the pace of recovery and future inflationary trends. There are a host of consumer price indices released this week, including in the US, UK and euro zone. Figures for the UK are published tomorrow, with the annual CPI rate forecast to nudge up slightly to 1.6% in November from 1.5% in October. The headline retail prices index (RPI) is expected to rise to 0.3% y/y, up from -0.8% in December and the first positive reading since January. November inflation data for the US and euro zone, due on Wednesday, should also show prices rising for the first time in several months. We look for US annual CPI inflation to accelerate sharply to 1.8%, up from -0.2% in October, primarily reflecting the recent rise in energy prices compared to the sharp falls late last year. The revised euro zone data are expected to show no change from the initial estimate of 0.6% in November, up from -0.1% in October. Although global annual inflation rates are likely to show further strong increases in coming months, we believe that any concerns about resurgent inflation are premature given the vast amount of spare capacity at present. For us, the risks of inflation and deflation further out are  still relatively closely balanced at this time.

 

􀂄 Following last week’s Pre-Budget Report (PBR), the UK’s public finances will again come under close scrutiny on Friday. We forecast the latest monthly data to show public sector net borrowing of £27.6bn in November, up sharply from £15.4bn last year. The data should highlight that although financial markets were relatively unmoved by the levels of projected gilt issuance shown in the PBR in coming years, their support should not be taken for granted. Other prominent UK releases this week include labour market data on Wednesday and retail sales on Thursday. We forecast a modest rise in claimant count unemployment in November, while the ILO unemployment rate is expected to be unchanged at 7.8% in the three months to October. The more restrained rise in UK unemployment compared to previous recessions and to the sheer extent of the recent fall in gdp (see chart) has been a key feature of this downturn. We believe this primarily reflects companies’ preferring to reduce pay and hours to contain labour costs on hopes that the downturn may prove short-lived. The clear risk is that final demand fails to meet their expectations, leading to further job losses next year. We look for the headline measure of average earnings growth to remain weak at slightly over 1% in the three months to October. Although the weak labour market will remain a key constraint on consumer spending for some time, we forecast UK retail sales rose modestly in November.

 

􀂄 The other key data highlights this week include a series of important surveys in the euro zone, notably the German ZEW and IFO and the December PMIs. We look for the surveys to signal that the overall pace of recovery will be maintained in the final quarter of 2009. The US November producer prices and manufacturing capacity utilisation data are expected to confirm that underlying price pressures remain subdued. Housing starts and permits, on Wednesday, could show a strong rebound after a surprise fall in October.

Jeavon Lolay, Senior Global Macroeconomist

 

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

 

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